England and Wales High Court (Chancery Division) Decisions

IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION
CHANCERY

		Royal Courts of Justice Strand, London, WC2A 2LL
		29/07/2009

Ms S Prevezer QC :

The Application

1. This is an application by the Joint Administrative Receivers (the "Receivers") of Harmony Care Homes Limited (the "Company") for a direction pursuant to Section 35 of the Insolvency Act 1986 (the "1986 Act") as to whether the book debt proceeds collected by them during the course of the administrative receivership of the Company should be applied and distributed (in part or in whole) to the First to Third Respondents (collectively "NHP"), holders of the debentures granted by the Company listed in the schedule to the Application and exhibited at "SH1" ("the Debentures"), or to the preferential creditors of the Company, including the Fourth Respondent, HM Revenue and Customs ("HMRC").
2. Before me, the Receivers were represented by Counsel, Ms Hilary Stonefrost. NHP were served with the Application in February 2009, and were served with notice of the hearing on 8 June 2009, followed by a letter of reminder dated 3 July 2009. However, they chose not to file any evidence or to be represented. Likewise HMRC. In accordance with an Order made by Mr Registrar Simmonds on 17 February 2009, the preferential creditors of the Company whose names and addresses were known to the Receivers, including HMRC, were sent a copy of the Application and the Order, which provided for the service and filing of evidence by any preferential creditor who wished to be joined as a Respondent. None of the preferential creditors filed evidence and HMRC expressly confirmed to the Receivers that it did not wish to attend the hearing.
3. The Receivers are presently holding £671,366.07, comprising the proceeds of book debt realisations together with interest which has accrued thereon ("the Monies"). The debt owed by the Company to NHP is £694,000 (excluding interest) and NHP is a preferential creditor in respect of £282,000 of this sum. The sum owed to the preferential creditors of the Company is £1,056,788. HMRC is the most substantial preferential creditor.
4. The Receivers are neutral as to whether the Monies are paid to NHP or to the preferential creditors. As no one has come forward to advance any claim to the Monies, the Receivers ask the Court to determine the issue and to make an order that does not come into effect until 14 days after the date of the Judgment, with a view to the Receivers serving the order on NHP, HMRC and the other preferential creditors of the Company whose addresses are known to the Receivers, so that those with an interest in the outcome have an opportunity to come before the Court if they wish to contest the order.

The Issue

5. Section 40 of the 1986 Act provides, so far as material, as follows:

"Payment of debts out of assets subject to floating charge

(i) The following applies, in the case of a company, where a receiver is appointed on behalf of the holders of any debentures of the company secured by a charge which, as created, was a floating charge

(ii) If the company is not at the time being wound up, its preferential debts (within the meaning given to that expression by section 386 in Part XII) shall be paid out of the assets coming to the hands of the receiver in priority to any claims for principal or interest in respect of the debentures

(iii) Payments made under this section shall be recouped, as far as may be, out of the assets of the company available for payment of general creditors.

6. The issue before the Court is whether the Monies held by the Receivers are subject to floating charges or fixed charges created by the Debentures, and specifically, whether, in the circumstances, the Debentures created, at their inception, fixed or floating charges over the book debt realisations collected by the Company. Unless the Monies are held to be the subject of floating charges, the receivership preferential creditors will, like the unsecured creditors, receive no payment from the realization of the book debts. If they are held to be the subject of floating charges, the preferential creditors will be entitled to the Monies and NHP's debt will be unsecured.

Background

7. The background to the Application is as follows. The Company was incorporated on 21 April 1998. The principal activity of the Company was the acquisition, development and management of long term care facilities for the elderly and for individuals with specialist care requirements. The Company operated 16 nursing homes (the "Homes") throughout England and Wales.
8. NHP were landlords of the Company's properties and the Company paid rent to NHP in that capacity. All 16 Homes have now been disposed of by the Receivers and the Company is no longer trading. It is likely that the Company will be dissolved at the end of the receivership.
9. The Company executed 16 debentures in favour of NHP between 11 September 1998 and 14 August 2000 in respect of the 16 Homes, including one called Hygrove House ("the Hygrove House Debenture"). The Debentures all have the same provisions governing the nature of the charge over the Company's book debts. The relevant terms of each of the Debentures for present purposes are as follows:

"Debts":

"all present and future book and other debts due owing payable or incurred to the Chargor including without prejudice to the generality of the foregoing any amounts from time to time standing to the credit of a designated account referred to in clause 5.1 below or any other bank accounts held by or on behalf of the [the Company]"

Clause 3.1:

"The [Company] as continuing security for the payment and discharge of the Secured Liabilities^[1] charges with full guarantee in favour of the [NHP]:...

" 3.1.2.5 all the right title and interest of the Chargor to and in the Debts."

Clause 3.2 :

"the Chargor as a continuing security for the payment and discharge of the Secured Liabilities charges with full title guarantee in favour of the Creditor by way of floating charge all the undertaking and all the assets, rights and income of the Chargor both present and future not otherwise effectively mortgaged or charged under Clause 3.1"

Clause 3.3 :

"The charges created by Clause 3.1 shall constitute fixed charges…"

Clause 3.4 provides that NHP may;

"convert the floating charge at any time by notice in writing to the Chargor into a fixed charge as regards any of the property and assets which for the time being are the subject of such floating charge if the Creditor believes its security over such property to be in jeopardy."

10. The restrictions on the disposal of the proceeds of the Debts are in clause 5 of the Debentures. Pursuant to Clause 5.1, during the subsistence of the Debentures the Chargor shall:

"Pay in to a separate designated account of the [Company] with the Bank ("the designated account") all monies which it may receive in respect of the Debts and pay or otherwise deal with such monies standing in such account in accordance with any directions from time to time given in writing by [NHP]; PROVIDED THAT:

5.1.1 prior to the floating charge created by this Debenture being converted into a fixed charge, in the absence of any directions from [NHP] any monies received by the [Company] and paid into such account in respect of the Debts shall upon payment in stand released from the fixed charge on Debts created by this Debenture and shall stand subject to the floating charge created by this Debenture over the other property and assets of the Chargor; and

5.1.2 any such release (as referred to in Clause 5.1.1 hereof) shall in no respects derogate from the subsistence and continuance of the said fixed charge on all other Debts of the Chargor for the time being outstanding:"

11. Further, Clause 5.3 requires the Company to deal with the Book Debts in accordance with directions given by NHP and provides that the Company shall:

"deal with the Debts in accordance with any directions from time to time given in writing by [NHP] (subject to any rights of the Bank in respect thereof) and in default of and subject to any such directions deal with the same only in the ordinary course of getting in and realising the same;"

The approach to ascertaining whether a charge is fixed or floating

12. In In re Yorkshire Woolcombers Association Limited [1903] 2 Ch 284 at p 295, Romer LJ stated what has come to be regarded as the classic description of a floating charge:

"I certainly do not intend to attempt to give an exact definition of the term `floating charge', nor am I prepared to say that there will not be a floating charge within the meaning of the Act, which does not contain all the three characteristics that I am about to mention, but I certainly think that if a charge has the three characteristics that I am about to mention, it is a floating charge. (1) if it is a charge on a class of assets of a company present and future; (2) if that class is one which, in the ordinary course of business of the company, would be changing from time to time; and (3) if you find that by the charge, it is contemplated that, until some future step is taken by or on behalf of those interested in the charge, the company may carry on its business in the ordinary way as far as concerns the particular class of assets I am dealing with"

13. In Agnew v Commissioners of Inland Revenue [2001] 2 AC 701, Lord Millett, commenting on this description, stated

"This was offered as a description and not a definition. The first two characteristics are typical of a floating charge but are not distinctive of it, since they are not necessarily inconsistent with a fixed charge. It is the third characteristic which is the hallmark of the floating charge and serves to distinguish it from a fixed charge. Since the existence of a fixed charge would make it impossible for the company to carry on business in the ordinary way without the consent of the charge holder, it follows that its ability to do so without such consent is inconsistent with the

fixed nature of the charge"

"A restriction on disposition [of book debts] which nevertheless allows collection and free use of the proceeds is inconsistent with the fixed nature of the charge; it allows the debt and its proceeds to be withdrawn from the security by the act of the company collecting it..."

14. Further, in deciding whether a charge is a fixed charge or a floating charge, Lord Millett stated, at Paragraph 32 of the Judgment, that the Court was engaged in a two stage process:

"At the first stage, it must construe the instrument of charge and seek to gather the intentions of the parties from the language they have used. But the object of this stage is not to discover whether the parties intended to create a fixed or floating charge. It is to ascertain the nature and the rights and obligations which the parties intended to grant each other in respect of the charged assets. Once these have been ascertained, the Court can then embark on the second stage of the process, which is one of categorization. This is a matter of law. It does not depend on the intention of the parties. If their intention, properly gather from the language of the instrument, is to grant the company rights in respect of the charged assets which are inconsistent with the nature of a fixed charge, then the charge can not be a fixed charge however they may have chosen to describe it…. In construing a debenture to see whether it creates a fixed or floating charge, the only intention which is relevant is the intention that the company should be free to deal with the charged assets and withdraw them from the security without the consent of the holder of the charge; or, to put the question another way, whether the charged assets were intended to be under the control of the company or of the charge holder"

15. The degree of control over book debts that is required to ensure that a charge over book debts is secure was further considered in In re Spectrum Plus Limited (in Liquidation) [2005] UKHL 41 by Lord Hope, who made clear that there are a limited number of ways to ensure that a charge over book debts is fixed. At Paragraph 54 of his opinion, Lord Hope stated:

"...One is to prevent all dealings with book debts so they are preserved for the benefit of the chargee's security....Another is to prevent all dealings with the book debts other than their collection and to require the proceeds when collected to be paid to the chargee in reduction of the chargor's outstanding debt...A third is to prevent all dealings with the debts other than their collection, and to require the collected proceeds to be paid into an account with the chargee bank. That account must then be blocked so as to preserve the proceeds for the benefit of the chargee's security. A fourth is to prevent all dealings with the debts other than their collection and to require the collected proceeds to be paid into a separate account with a third party bank. The chargee then takes a fixed charge over that account so as to preserve the sums paid into it for the benefit of its security."

What was the scheme created by the Debentures

16. On the plain wording of the Debentures, the security granted to NHP is expressed to be a fixed charge on the uncollected Debts, and, in the absence of any directions from NHP, a floating charge on the proceeds of the debts on their receipt. Clause 5.1.1 requires the payment of book debt realisations by the Company into a designated account of the Company with the Bank, and provides that on their receipt by the Company and absent any directions from NHP, the book debt realizations shall be released from the fixed charge and shall stand subject to the floating charge created by Clause 3.2 of the Debentures.
17. However, the Court is bound to consider the true nature of the rights and the obligations which the parties intended to grant each other in respect of the charged assets at the inception of the Debentures, and not simply the way the parties have categorized their relationship. Accordingly, in the present instance, the Court must consider whether there were in fact any directions from NHP and/or any restrictions placed by NHP on the Company on the grant of and pursuant to Clause 5.1 of the Debentures, such that the book debt realizations were not released from the fixed charge on their receipt by the Company, but were permanently appropriated to the security which was given to NHP on the grant of the Debentures.
18. The Company's ability to deal with its book debt realizations has to be considered at the time the Debentures were granted. Section 40 of the 1986 Act is concerned with the position where a charge "which as created" was a floating charge, and the date of creation of a charge is the date on which the charge is executed; Re Shoe Lace Limited, Power v Sharp Investments Ltd [1993] BCC 609. The legislative purpose of the words "as created" in Section 40 is to ensure that a charge that is originally created as a floating charge but which becomes a fixed charge by reason of crystalisation or by notice of conversion does not have the effect of changing a pre-existing floating charge to a fixed charge to the detriment of preferential creditors; Re Brightlife Limited [1987] Ch 200.
19. Moreover, where the chargor is permitted until the occurrence of a specified event to remove the charged assets from the security, the charge should, in principle, be categorized as a floating charge. As Blackburne J held in In Beam Tube Products Limited [2006] EWHC 486 (Ch), it is irrelevant that some months after the execution of the debenture, the company finds itself restricted from freely using the proceeds of the book debts then and thereafter becoming available, as a result of the setting up of a blocked account. Section 40 of the 1986 Act requires the payment of preferential creditors out of the charge `as created as a floating charge'. If the scheme is in fact that the proceeds of all book and other debts should be subject to a floating charge, then the charge, as created, is a floating charge.
20. NHP has provided some, albeit incomplete, information to the Receivers on the controls that it imposed on the Company's handling of its book debt receipts in relation to the 16 homes it operated.
21. In an initial letter dated 8 July 2003, NHP informed the Receivers that:

"We firmly believe that NHP hold a valid fixed charge over the book debt proceeds of Harmony. The extent of NHP's control over the designated fee accounts into which the book debt proceeds were paid was clearly set out in the respective mortgage debentures, and, for at least a year prior to Harmony being placed in receivership, all transfers from the designated fee accounts were made at NHP's absolute discretion and solely by way of specific individual instructions issued direct to the bank by signatories who were officers of NHP. Not only did NHP have the right to fully control the book debt proceeds, NHP also actively exercised this right."

In support of these assertions, NHP provided documents to the Receivers which evidenced that there had been controls on the proceeds of book debts from January 2001 in relation to the Hygrove House Debenture which had been executed in April 1999. No evidence was provided in relation to any of the other homes.

22. Subsequently, in a letter dated 21 June 2006, NHP provided a further explanation of the way in which control was purportedly exercised over the proceeds of book debts:

"The accounts were swept to the Harmony operating accounts to enable them to meet day-to-day expenses. Any monies swept to NHP bank accounts were for rent.

It appears from the records that sweeps were made almost daily and that these would have been prompted by funds being received.

Control of the fee accounts is part of the mortgage debenture in the lease and would have been implemented at signing of the lease. The leases were undertaken in 1999 and NHP has controlled the accounts since then.

All accounts for Harmony homes were operated the same by NHP. Balances of the accounts were obtained from Harmony along with budgeted daily expenses. NHP helped Harmony to meet these expenses before taking any remaining funds for rent."

23. The documents provided to the Receivers with this letter showed:

(i) A list of all payments made from Hygrove House fees account from 1 January 2001 to 7 January 2002. The Receivers were appointed on 7 January 2002 and the final instruction on the list is a specific request from NHP "to transfer all cleared funds." and

(ii) A bank statement showing the entries between 1 January 2001 and 9 January 2002 for the Home known as Guide Lane, which showed receipts and payments for the Guide Line Current Account.

24. On 14 August 2008, NHP provided some additional information to the Receivers concerning the operation of the accounts for Hygrove House, in particular, further documents showing that NHP had imposed controls on the proceeds of book debts before January 2001. The documents included:

(i) Bank statements for Hygrove House that show the account was opened on 8 July 1999.

(ii) The Company account opening form for Hygrove House. The account is described as a "Current Account" and the address for statements and correspondence is given as NHP's address.

(iii) Documents that show the board of the Company resolved that the signatories on the account were directors or employees of NHP The authorised signatories' sheet states that it is to be used in conjunction with a mandate dated 9 April 1999; and

(iv) A bank mandate that was executed on 1 July 1999

It is stated by NHP that the system operated for Hygrove House was also in place for the other Homes, although NHP has not produced equivalent documentation for the other 15 homes.

25. The Hygrove House Debenture was granted on 23^rd April 1999. It is clear on the evidence that an account for Hygrove House was opened on 8 July 1999 with a mandate in favour of NHP on that account, which the Company resolved to grant in April 1999. There is no evidence that there was any other account that was operated by the Company in respect of Hygrove House in the period between 23 April 1999 and 8 July 1999, and it is reasonable to conclude on the evidence that from the opening of the account on 8 July 1999, the Company could not make and did not make any use of the monies paid into the account without NHP's written instructions to the Bank. Accordingly, it appears that all book debts collected in by the Company in respect of Hygrove House from the inception of the Hygrove House Debenture were subject to NHP's control and that, unlike the position in Spectrum, from the outset, the status of NHP's security over the book debts was specific and ascertained. In short, there was never a moment from the inception of the Hygrove House Debenture when the Company was entitled to remove the charged assets from the security, and unlike the situation in Spectrum, the effect of the Debenture and the arrangements the parties put in place pursuant thereto, was to disentitle the Company from using the proceeds of the book debts as a source of its cash flow or for any other purpose.
26. Accordingly, applying the guidelines laid down in Agnew v CIR and Spectrum, it is, in my view, right for the Court to conclude that the security granted to NHP in respect of the book debt realizations from Hygrove House was intended to be and was in fact a fixed charge, and that NHP had the degree of control over the book debts collected in by the Company that is requisite for a fixed charge. The Company was not free from the inception of the Hygrove House Debenture to deal with the book debt realizations and/or to withdraw them from the security without the consent of NHP; putting it another way, the charged assets were intended to be and were in fact under NHP's control.
27. However, the evidence which NHP has provided to the Receivers to date is not sufficient to enable the Court to draw a similar conclusion in respect of the security granted over the book debt realizations collected by the Company from the other 15 homes operated by the Company. Although I accept that the parties may have intended to operate a similar system in respect of all 16 homes, the evidence provided by NHP to date does not go far enough to establish that this in fact occurred. In the absence of further information (akin to that provided in relation to Hygrove House), it is simply not open to the Court to conclude that the book realizations collected in by the Company in respect of the other 15 homes are caught by fixed charges in favour of NHP.
28. The Receivers have done all they can to encourage those with an interest in the Monies to file and serve evidence and to come before the Court, and it is somewhat surprising, given the amount of money at stake, that NHP has not produced the information required to make good its case with regard to the other 15 homes. However, given that the Receivers are neutral on the issue and that, equally, no preferential creditor has come forward to make claim to the Monies, what I propose to do in the circumstances is to make an Order which provides for a further period of 28 days within which NHP should have the opportunity to produce evidence, to the satisfaction of the Receivers, that the book debt realizations in respect of the remaining 15 homes were dealt with in a similar way to those collected in relation to Hygrove House. In the event that NHP fail to produce such evidence, then that portion of the Monies relating to book debts collected in from those 15 homes shall be held to be subject to a floating charge (s) and available to pay the preferential creditors of the Company. In my view, it is appropriate to grant NHP this further short period to produce evidence in support of their claim to the Monies, as NHP has indicated (in its letter of 21 June 2006) that all accounts for Harmony homes were operated the same by NHP and NHP may (mistakenly) be relying on this letter as sufficient for the purposes of establishing their claim in respect of the other 15 homes.
29. As requested by the Receivers, the order made by this Court will not take effect for a period of 56 days from the date hereof, thereby allowing NHP 28 days to provide any further information it may have to the Receivers in relation to the remaining 15 homes and allowing a further 28 days thereafter for the Receivers to notify NHP, HMRC and the other preferential creditors known to them of this order and the Receivers determination with regard to the remaining 15 homes. If during this latter 28 day period, any of the parties notified indicate to the Receivers that they wish to contest the order, then this matter will need to be relisted before me pursuant to CPR Rule 23.11 at a time convenient to the parties.
30. Finally, I direct that the Receivers are entitled to their costs of this Application to be paid as an expense of the Administrative Receivership.

Note 1       [Back]